Q2 2004 "Flow of Funds"

The week seemed to confirm the resiliency of "global reflation," with prices
of things real and financial biased upward (inflating). As for U.S. equities,
the Dow dipped slightly, while the S&P500 gained less than 0.5%. The Transports
added 1%, increasing y-t-d gains to 8.3%. The Utilities added 0.4%, with 2004
gains of 8.5%. The Morgan Stanley Cyclical index was about unchanged, while
the Morgan Stanley Consumer index declined 1%. The broader market remains resilient,
with the small cap Russell 2000 and S&P400 Mid-cap indices up about 0.5%
(y-t-d about 3%). The NASDAQ100 gained 1%, while the Morgan Stanley High Tech
index rose 1.3%. The Street.com Internet index gained 2%, increasing y-t-d
gains to 9.3%. The NASDAQ Telecommunications index declined 1.7% for the week.
The Biotechs surged 5%, increasing 2004 gains to 9.5%. The financial stocks
were mixed, with the Broker/Dealers down 1% and the Banks slightly positive.
With bullion up $2.90 to $405.65, the HUI gold index gained 1%.

September 16 - Bloomberg (Alex Kennedy): "Venezuela's benchmark bond maturing
in 2027 rose to a record high as a rally in oil prices boosted the foreign
reserves of the world's fifth-largest crude supplier. The 30-year bond rose
1.70 cents on the dollar to 98.20, paring the yield to 9.44 percent..."

September 16 - Bloomberg (Lianne Gutcher): "The performance of hedge funds
is at its worst in six years, the Financial Times reported, citing the CSFB
Tremont hedge fund index. Hedge funds returned an average 2.75 percent in the
year to date, down from the 11 percent recorded over the past decade, the FT
said. In August, the average profit was 0.1 percent... Not since 1998, the
year Long-Term Capital Management collapsed, have hedge funds performed so
badly..."

Freddie Mac posted 30-year fixed mortgage rates dropped 8 basis points this
week to 5.75%, the lowest rates since the first week of April. Fifteen-year
fixed mortgage rates declined 9 basis points to 5.13%, with rates now down
49 basis points in 11 weeks. One-year adjustable-rate mortgages could be had
at 4.03%, down 3 basis points. The Mortgage Bankers Association Purchase application
index dipped 4.3% last week. The holiday week again this week distorts year-over-year
comparisons. Refi applications added 1.2%. The average Purchase mortgage was
for $218,300, and the average ARM was at $298,200. ARMs accounted for 33.0%
of total applications last week.

Major currencies remain choppy and range-bound (for now). The dollar index
posted a gain of about 0.5%. The "emerging" currencies (at the "periphery")
continue to perform very well. The Indonesian rupiah gained 2.6% this week,
the Uruguay peso 2%, Brazilian real 1.3%, Mexican peso 1.2%, and Chilean peso
1.1%. On the losing end, the Turkish lira declined 1.6% and the Norwegian krone
1.4%.

Commodities Watch:

September 14 - XFN: "China's imports of crude oil in the first eight months
of this year rose 39.3% year-on-year to 79.96 million tons, the Xinhua News
Agency reported, citing figures from the General Administration of Customs."

September 17 - Bloomberg (Tan Hwee Ann): "BHP Billiton, Rio Tinto Group and
rival miners may be able to raise contract prices for iron ore by 20 percent
next year to cover rising costs and as Chinese demand continues to rise, Goldman
Sachs JBWere Pty said... The brokerage had earlier forecast a 10 percent increase...
Iron ore prices rose to a record this year, boosted by rising Chinese demand
for the raw material to make steel."

For the week, the CRB index rose 1.0% (y-t-d gains of 7.5%). October crude
was up $2.78 to $45.59, a near four-week high. The Goldman Sachs Commodities
index jumped 4.6% this week, increasing y-t-d gains to 20.5%.

China Watch:

September 14 - AFX: "China's August enterprise commodity prices, a measure
of wholesale prices, rose 0.6% from July and 9.5% year-on-year, the
People's Bank of China said. The central bank said in a statement that Jan-Aug
enterprise commodity prices rose 8.6% year-on-year, while wholesale prices
for investment goods rose 0.7% from July and 9.7% year-on-year."

September 13 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's
export growth unexpectedly picked up in August, suggesting slowdowns
in the U.S. and Japanese economies have yet to curb demand for toys, clothes
and electronics goods made in the world's most-populous nation. Overseas
sales increased 38 percent from a year earlier to $51.4 billion last
month, the commerce ministry said... That's up from 34 percent growth in
July..."

September 15 - Bloomberg (Philip Lagerkranser): "Foreign direct investment
in China rose in the first eight months as companies including Toyota Motor
Corp. and Akzo Nobel NV expanded to take advantage of low wages and tap rising
demand. Foreign investment increased 19 percent from a year earlier to $43.6
billion in the eight months through August after gaining 15 percent in the
first seven months, the Beijing-based Ministry of Commerce said..."

September 17 - Bloomberg (Jianguo Jiang): "China's property prices in the
first eight months grew at their fastest pace in eight years. Prices
for homes, offices and other commercial real estate surged 13.5 percent from
a year ago to an average 2,749 yuan ($332) a square meter (10.764 square
feet), the National Bureau of Statistics said..."

September 16 - Bloomberg (Tian Ying): "Investment in China's factories, roads
and other fixed assets grew more slowly in August as government lending curbs
damped industrial expansion. Investment rose 30.3 percent to 3.22 trillion
yuan ($389 billion) in the first eight months of this year after climbing 31.1
percent through July, according to Beijing-based Mainland Marketing Research
Co."

September 15 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's retail
sales increased 13.1 percent last month as higher incomes made holidays, cell
phones and computers more affordable. Sales rose to 426 billion yuan ($51.5
billion), the Beijing based National Bureau of Statistics said... The gain
followed a 13.2 percent increase from a year earlier in July..."

September 15 - Bloomberg (Jianguo Jiang): "China's restaurants had combined
sales of 60.6 billion yuan ($7.3 billion) in August, an increase of 20 percent
from a year earlier, the commerce ministry said. Restaurant sales rose 23 percent
to 456.1 billion yuan in the first eight months, accounting for 14 percent
of the country's retail sales..."

September 16 - Bloomberg (Samuel Shen): "More urban Chinese are willing to
increase their spending even after consumer prices rose for a second month,
a People's Bank of China survey found. The bank found 32.3 percent of people
surveyed think that it's more reasonable to step up spending this quarter,
even by borrowing from banks, given current interest rates and consumer prices.
That's an increase of 1.1 percentage points from the previous quarter... The
bank said that even though residents are less satisfied with current consumer
prices 'willingness for consumption continues to rise.'"

September 13 - Bloomberg (Philip Lagerkranser): "China plans to boost spending
on research by government-owned companies fivefold as part of efforts to upgrade
and restructure state industry, the nation's top official in charge of state
assets said. Research spending will rise to 5 percent of revenue from 1 percent
last year..."

September 15 - Bloomberg (Philip Lagerkranser): "Goldman Sachs Group Inc.
cut its 2005 economic growth forecast for China, citing slowing export growth,
and said the outlook may worsen unless the government replaces lending curbs
with higher interest rates. The forecast was lowered to 8.1 percent from 8.3
percent..."

Asia Inflation Watch:

September 15 - Bloomberg (Meggan Richard and Hector Forster): "Japan's power
generation rose for a fifth consecutive month in August, gaining 4.4 percent
from a year earlier because of increased use of air conditioners and higher
demand from industrial customers."

September 17 - Bloomberg (Cherian Thomas): "Indian exports rose 28 percent
in August from a year ago as Gujarat Ambuja Cements Ltd. and rival cementmakers
sold more overseas and steel companies stepped up shipments to China. Exports
were $5.6 billion last month, the Commerce and Industry Ministry said... Imports
rose 25 percent to $7.1 billion, boosted by higher oil costs."

September 17 - Bloomberg (Amit Prakash): "Singapore's exports unexpectedly
rose in August, boosting an economy that the manpower minister said may grow
by more than 10 percent this year for the first time in a decade."

September 17 - Bloomberg (Seyoon Kim): "South Korea's foreign-exchange reserves,
the fourth biggest in the world, rose to a record... Reserves, including foreign
currency, gold and drawing rights in South Korea's International Monetary Fund
reserve account, rose $1.9 billion since the start the end of August to $172.4
billion..."

September 15 - Bloomberg (Jun Ebias): "Philippine government debt jumped by
a fifth in March from a year earlier because the state sold bonds overseas
to help fund an estimated 198 billion peso ($3.5 billion) budget deficit for
this year."

September 15 - Bloomberg (Soraya Permatasari): "Indonesia's auto sales in
August rose 29 percent from a year before, aided by record low interest
rates and an expanding economy, PT Astra International said, citing figures
from the Association of Indonesian Automotive Industries."

Global Reflation Watch:

September 16 - Bloomberg (Julie Ziegler): "The world economy will expand by
at least 5 percent this year, the strongest performance in two decades, the
Institute for International Economics said. The projection is up from an April
forecast of 4.75 percent."

September 14 - Bloomberg (Tim Kelly): "Corporate bankruptcies in Japan fell
13 percent in August from a year earlier to 1,097 cases, the lowest for the
month in a decade as five quarters of economic growth boosted profits, Tokyo
Shoko Research Ltd. said. The number of bankruptcies fell for a 24th consecutive
month..."

September 17 - Bloomberg (John Fraher): "German producer prices rose the most
in three years in August as the price of oil climbed to a record, contributing
to euro-region inflation that exceeded the European Central Bank's 2 percent
ceiling for a fourth month. Prices for goods ranging from toys to machine tools
advanced 2.2 percent from a year earlier..."

September 16 - Bloomberg (Dylan Griffiths): "South African business confidence
rose to a 16-year high in the third quarter of 2004, following six interest
rate cuts in the past 16 months, a survey showed."

September 16 - Dow Jones - "Brazil's tax receipts rose 22% in real terms in
August compared with the same period a year ago as government coffers continued
to benefit from economic growth and a welfare tax rate increase earlier in
the year."

September 17 - Bloomberg (Romina Nicaretta): "Brazilian retail sales rose
for a eighth month in July as falling unemployment boosted sales of food and
declining rates on consumer loans increased sales of cars and appliances such
as refrigerators and television sets."

September 16 - Bloomberg (Daniel Helft and Andrew Barden): "Argentina said
it plans to increase spending 14.4 percent next year to compensate utilities
for higher energy costs, build roads and housing and make its first payments
on international bonds since the government's 2001 debt default."

California Bubble Watch:

September 14 - Los Angeles Times (Annette Haddad): "Los Angeles County housing
prices continued their more than yearlong run of double-digit increases last
month, with the median price paid for all homes rising 20.4% to $407,000 from
a year ago. To be sure, the pace of appreciation has slowed from the peak reached
earlier this year... August also saw 10,710 sales of new and existing houses
and condominiums. That made August the sixth straight month that more than
10,000 transactions occurred..."

September 17 - San Francisco Chronicle (Kelly Zito): "The Bay Area housing
market re-entered the record books in August as the median price jumped to
$520,000 and sales for the month hit their highest level in at least 16 years...
Defying long-held expectations that demand would taper off, the boom continues
apace, reigniting debate about whether the Bay Area housing market is reaching
unstable heights... The median price for a single-family home, as opposed to
the overall median, was $549,000..."

U.S. Bubble Economy Watch:

September 16 - Dow Jones (Rob Wells): "A new report finds U.S. multinational
corporations socked away profits of $149 billion in 18 tax havens in 2002,
nearly double the level three years earlier. Tax Notes, an industry magazine,
said in a report Monday the money is being funneled to Bermuda, Ireland, Luxembourg
and Singapore instead of the U.S. Treasury. 'That means those 18 tax havens
were home to 58% of the foreign profits of those multinationals - a figure
that far exceeds the share of economic activity that multinationals conduct
in those low-tax countries," according to the report by Tax Notes correspondent
Martin Sullivan. 'Subsidiaries of U.S. corporations now generate profits mainly
in tax havens rather than in the locations in which they conduct most of their
business,' the report said."

Mortgage Finance Bubble Watch:

September 17 - AP: "Fraud is running rampant in the nation's mortgage industry,
with nearly three times as many reports of suspicious activity so far this
year compared with 2001, a top FBI official said Friday. 'It has the potential
to be an epidemic,' said Chris Swecker, FBI assistant director for criminal
investigations. Through the first nine months of 2004, mortgage companies and
banks have reported more than 12,100 instances of suspicious activity compared
with only 4,220 in 2001... Law enforcement officials say the lending and
refinancing boom that accompanied record low interest rates in the past few
years is a key reason for the increased fraud. The FBI has identified several
'hot spots' around the country where fraud is especially prevalent, including
Florida, California, Nevada, Michigan, Missouri and Illinois. 'You can find
this anywhere in the country,' Swecker told reporters. One common mortgage
fraud scheme is 'property flipping,' in which property is purchased, appraised
fraudulently at a much higher price and then quickly sold."

California ARM lender Golden West Financial enjoyed another record month of
originations ($4.87bn) during August. Loans expanded at a 37% rate during the
month to $94.5 billion, with loans growing at a 33% pace during the past five
months. On the liability side, Deposits were up $3.48 billion over the past
five months (17.6% ann.) to $50.9 billion and borrowings from the FHLB were
up $7.0 billion (67% ann.) to $31.78 billion. Over the past year, Loans have
expanded 34%, financed by 11% deposit growth and a 66% increase in FHLB advances.

Q2 2004 "Flow of Funds"

The Fed yesterday released the second quarter Z.1 "flow of funds" report.
Total Credit Market Borrowings (non-financial and financial) increased at a
$2.59 Trillion seasonally-adjusted annualized rate (22% of GDP) to $35.18 Trillion.
First-half total net additional borrowings were at a $2.67 Trillion annual
pace, compared to the nineties yearly average of $1.28 Trillion. While second
quarter borrowings were down slightly from the first quarter, they compare
to total borrowings of $1.70 Trillion during 2000, $1.97 Trillion during 2001,
$2.16 Trillion during 2002, and $2.64 Trillion during 2003. After beginning
1998 at 250%, Total Credit Market borrowings have increased to 302% of GDP.

Total Non-financial Credit expanded at a 7.7% annualized rate during the second
quarter, down from the first quarter's 9.1% rate. Still, one has to go all
the way back to 1988 for a year of stronger non-financial Credit expansion
(9.1%). And it is worth noting that non-financial growth averaged 5.4% during
the last decade. The Federal Government expanded debt at a 10.7% pace during
the quarter, with first-half borrowings expanding at an 11.5% rate. We must
go back to the deficits from the early-nineties (recession and S&L bailout)
to find anything comparable. Federal debt has expanded 22% over the past 24
months to $4.27 Trillion. State & Local governments borrowed at a 7.2%
rate during the first-half (4.6% during the 2nd quarter).

The Household sector expanded borrowings at a 9.5% annual rate during the
quarter to $9.74 Trillion, with debt expanding at a 10.5% pace during the first-half.
Total Household Borrowings are up an eye-opening 22% (matching federal debt
growth) over the past 24 months. Meantime, Total Corporate borrowings expanded
at 4.4% rate during the quarter (4.6% first-half pace), with non-financial
Corporate debt expanding at a 2.9% rate.

It is worth noting that Federal and Household borrowings have over the past
two years increased a combined $2.50 Trillion, while non-financial Corporate
debt has risen $287 billion. During the decade of the nineties, Federal and
Household debt growth combined for an average annual increase of $454 billion
(debt growth that took more than 5 yrs during the nineties now takes 2 yrs).
There is, then, no mystery surrounding the fountainhead for robust corporate
cash flows and profits. But I would warn against extrapolating the effects
of historic federal and household sector debt booms too far into the future.

The Great Mortgage Finance Bubble certainly runs unabated. Total Mortgage
Debt expanded by $283.4 billion during the quarter ($1.076TN seasonally-adjusted,
annualized) to $9.85 Trillion. Total annual Mortgage debt growth averaged $276
billion during the nineties (what used to take a year now is done in a quarter).
The first quarter's expansion was second only to last year's second quarter,
with a growth rate of 11.8%. Total Mortgage Credit was up $1.03 Trillion over
the past year (12.0%), $1.92 Trillion over two years (24%), and $4.82 Trillion
over seven years (97%). Household Mortgage borrowings expanded at an 11.9%
rate during the quarter to $7.57 Trillion (up 12.3% over one year). Home Equity
borrowings (a component of Household mortgage debt) expanded by $53.6 billion,
or 30% annualized, during the quarter to $766.2 billion (up 23% y-o-y). Commercial
Mortgage Borrowing increased at an 11.8% rate to $1.61 Trillion. Total Mortgage
Debt has inflated from 64% of GDP at the start of 1998 to 86% by the end of
the second quarter.

The U.S. financial sector increased borrowings at a 7.9% rate during the first
quarter to $11.47 Trillion. Financial sector debt has now doubled in size since
the beginning of 1998. It is fascinating to follow the evolution of the financing
mechanisms fueling the Credit Bubble. Years of asset inflation (securities
and real estate) was fueled in large part by spectacular GSE and money market
fund expansion. Yet, today, these liquidity sources have been supplanted by
aggressive Bank Credit expansion (real estate and securities), ballooning foreign
central bank holdings, and the mushrooming "repo" (securities financing) market.
Asset inflation begets myriad institutions and individuals aggressively seeking
their share of easy financial "profits."

Commercial Bank Total Assets expanded at a 7.8% rate during the quarter to
$8.2 Trillion. Bank Assets were up 8.2% from a year earlier. Bank Loans expanded
at a blistering 10.9% rate during the quarter, with Loans growing at an 8.9%
rate during the first-half to $4.6 Trillion. For comparison, Bank Loans expanded
by 5.6% during both 2002 and 2003. Of course, mortgage lending is leading the
way. Total Bank Mortgage assets expanded at a notable 18.3% rate during the
quarter to $2.44 Trillion, with mortgage loans increasing at a 16% pace during
the first-half. Total Bank Credit expanded at a 10.7% rate during the first
half to $6.53 Trillion, with Government Securities holdings expanding at a
21% rate to $1.25 Trillion.

Examining Bank liabilities, total deposits (checkable, savings and time) expanded
at an 11.4% rate during the quarter to $4.8 Trillion. Total deposits were up
8.3% y-o-y and 17% over two years. Fed Funds & Repurchase Agreements (net)
expanded at a 16% rate during the quarter to $1.01 Trillion, with two-year
growth of 32%. With cheap deposit and repo finance abundant, Bank Credit Market
Borrowing slowed sharply to a 4% growth rate during the quarter to $710 billion,
with y-o-y gains of 11.1% (up 23.6% in 2-yrs).

There continue to be interesting developments throughout "Structured Finance." And
keep in mind that, with buoyant bank lending and deposit growth, there is today
somewhat less reliance on the (non-ABS) securitization marketplace. GSE assets
expanded at a 6.4% rate during the quarter to $2.83 Trillion, following two
quarters of uncharacteristically slow growth (about 2%). GSE assets were up
6.9% y-o-y and were up 158% since the beginning of 1998. FHLB "Other Loans
and Advances" expanded at an extraordinary 32% rate during the quarter to $558.1
billion. Issuance of GSE mortgage-backeds remained slow during the quarter
(1.5%), with y-o-y growth of 7% to $3.52 Trillion. GSE MBS is, however, up
93% since the beginning of 1998.

The hot game has become "non-conforming" mortgages securitized in the ABS
(asset-backed securities) marketplace. Non-GSE mortgage ABS expanded at an
unprecedented seasonally-adjusted and annualized pace of $326.2 billion (more
than Total Mortgage borrowings increased during any year until 1998). For comparison,
mortgage loans comprised $80.8 billion of ABS issues during 1999, $68.7 billion
during 2000, $116.8 billion during 2001, $90.1 billion during 2002, and $184.5
billion last year. In total, outstanding ABS expanded at a 12.8% rate during
the quarter to $2.49 Trillion, up sharply from the first-quarter's 3.9% growth.
Total ABS was up 8.1% y-o-y and a stunning 152% since the beginning of 1998.

Other financial sector developments are worth noting. Federal Reserve assets
expanded at a 10% rate during the quarter to $807.8 billion, increasing 12-month
gains to 5.0%. Savings Institutions (ARM lenders) expanded assets at a 9.3%
rate during the quarter to $1.55 Trillion, with assets up 11% over one year.
REIT assets expanded at a 30% annualized rate during the quarter to $143 billion,
with y-o-y gains of 42%. Credit Unions expanded assets at a 5.4% rate during
the quarter to $643 billion (up 5.5% y-o-y). Finance Company assets declined
at a 4.1% rate to $1.386 Trillion, although assets were up 11% over the past
12 months.

The disintermediation from Money Market Funds (MMF) continues. MMA assets
declined at a 12% rate during the quarter to $1.912 Trillion, and were down
$208.5 billion during the past year. But keep in mind that many institutions
are choosing to invest in money market instruments (short-term Treasuries,
CP, ABS, agency debt, and "repos") directly rather than through a fund. And
while the nature of the Credit expansion would tend to reduce the growth rate
of the M's, it would not at all impinge marketplace liquidity.

The Broker/Dealer sector balance sheet remains quite "fluid." After the first-quarter's
$115.8 billion surge to $1.676 Trillion (29% annualized growth), Broker/Dealer
assets declined $53.3 billion during the second quarter (as interest rates
spiked). This drop was almost completely explained by Treasury security sales.
The Liability side saw an $87 billion reduction in Security RP (repo) to $408.3
billion, while Due to Affiliates increased by $46.1 billion (30% annualized)
to $651.7 billion. Over the past year, Broker/Dealer assets have increased
$163.4 billion, or 10.8%.

Funding Corp assets expanded at a 9% rate during the quarter to $1.242 Trillion,
with y-o-y gains of 8.6%. Funding Corp. "Investment in Broker and Dealers" rose
$37.5 billion (38% annualized) to $428.3 billion. After two big quarters, Federal
Funds and Security Repurchase Agreements declined at an 11% rate to $1.585
Trillion. This reduced the 12-month increase to $144.3 billion, or 10.0%.

Rest of World (ROW) - the foreign sector - remains a fascinating and challenging
area for analysis. Our foreign Creditors' "Net Acquisition of Financial Assets" dipped
slightly to a seasonally-adjusted annualized $956.4 billion during the quarter.
Holdings have expanded at a 16% pace over the past three quarters and were
up $994.2 billion, or 12.7%, over the past year. "Official" holdings of Treasuries
and Agencies expanded at a 21% rate during the quarter to $1.33 Trillion (ROW
Treasury holdings increased more than Treasury issuance). "Official" holdings
were up $361.6 billion, or 37%, over the past year. Holdings of "Security Repo" expanded
at a 16% pace during the quarter to $552 billion, an increase of 51% from one
year ago and up from $91 billion at the end 2000. Foreign holdings of U.S.
corporate debt (including ABS) expanded at a 13.7% rate during the quarter
to $1.61 Trillion, with a y-o-y gain of 16%. Foreign Direct investment increased
$34.5 billion during the quarter, or 8.9% annualized, to $1.60 Trillion (up
3.3% over one year).

Confusing the issue, there were some major revisions to ROW U.S. liabilities
(foreign borrowings in the U.S.). For example, last quarter's Z.1. report had
ROW Total Liabilities of $3.255 Trillion that one could net against the $8.427
Trillion of Total U.S. Financial Assets held for net U.S. holdings of $5.17
Trillion. Yesterday's release revised Q1 Total Liabilities a mere $905 billion
to $4.160 Trillion. And while Foreign Assets were also revised somewhat higher,
last quarter's net foreign holdings has been revised down to $4.49 Trillion.
Second quarter net foreign holdings, then, were up $658 billion, or 17%, from
one year ago to $4.55 Trillion.

During the second quarter, the value of Household asset holdings increased
by $900.4 billion to a record $55.97 Trillion. Meanwhile, Liabilities increased
by less than one third of this amount at $263.4 billion, to end the quarter
at $10.16 Trillion. Over the past year, Household assets increased $5.50 Trillion,
or 10.8%, while Liabilities expanded $857 billion, or 9.3%. So despite record
borrowings, Household Net Worth increased $637 billion during the quarter to
a record $45.91 Trillion. Net Worth was up $4.59 Trillion over the past year,
or 11.1%. Household Financial Asset holdings were up $369 billion (4.2% ann.)
to $35.2 Trillion during the quarter, with 12-month gains of $3.48 Trillion
(11%). Household Real Estate holdings increased by $467 billion during the
quarter, or 11.2%, to $17.14 Trillion and were up $1.77 Trillion, or 11.5%
over the past year. Since the beginning of 1998, Household real estate holdings
have increased 76%, as inflating nominal market values more than doubled the
increase in mortgage debt.

But the bottom line is that Household debt has increased more than 60% since
the beginning of 1999, and this historic borrowing surge has actually accelerated
of late. And while there continues to be a debate as to whether the consumer
is "tapped out," it is my view that this line of analysis misses the point.
During this fateful Mortgage Finance Bubble "blow-off" period, extraordinary
gains in both asset values and liquidity lend great support to consumer spending.
I continue to expect consumer retrenchment to follow some type of negative
financial development, rather than precipitating one.

How long with the Rest of World accumulate U.S. financial instruments at a
nearly $1 Trillion annual pace? And while they are acquiring the vast majority
of Treasuries issued, what types of financial and economic distortions are
nurtured by artificially low yields and rampant global liquidity excesses?
Does the U.S. economy's vulnerability to inflated Household Sector New Worth
only become more precarious by the year? Are market participants kidding themselves
with notions that tame U.S. and global inflation lies behind the recent decline
in yields? Is the Treasury market in the midst of a major "short-squeeze" and
hedging/derivatives dislocation that now leaves the marketplace and the highly-leveraged
U.S. financial sector acutely vulnerable to an abrupt reversal? The "flow of
funds" reports quite effectively illuminate the ongoing Credit inflation and
financial sector leveraging that have fostered unparalleled financial fragility
and specific interest-rate and currency market vulnerability.